Monday, April 27, 2015

Housing Tax Policy, A Series: Part 29 - Down Payments: More dogs not barking.

What do you think a graph of down payments in the 2000s would look like?  It would be plummeting, right?  That's how the banks pulled marginal households into the market, right?

Here's a graph from the FHFA of down payments on conventional mortgages on all homes, nationwide.  (This is 100 minus the Loan to Price value in the source data.)  From 2000 to 2005, down payments became substantially larger.

And, notice when they suddenly dropped to much lower levels:  2006 and 2007 - after house prices had leveled off and began to fall.  The period where I have been arguing that the Fed was already creating a liquidity shortage.  Then down payment levels recovered in 2008.  Of course, by 2007, and especially by 2008, mortgage originations were very low.  In fact, conventional loan originations had begun to fall by 2004 and 2005.

But, this is just conventional mortgages, right?  Wasn't the real damage in subprime?  Here is a table from the Demyanyk and Van Hemert paper that I referenced the other day.  This lists several characteristics of subprime loans.  This comes from loan level data from CoreLogic.  Combined Loan to Value ratios on these loans rose from 79.4% in 2001 to 85.9% in 2006.  This includes all loans, not just the first lien mortgage.  Here we see a mirror image of the downpayments in the conventional loans, with a reduction in down payments as a percentage of the home price of 6.5%.  That is something.

But, take a look at the average loan size.  It grew from $126,000 in 2001 to $212,000 in 2006.  That means that in dollar terms, in 2001 the average down payment was $32,690 and in 2006 it was $34,799.  In dollar terms, down payments rose slightly, even among subprime loans.

Further, let's think of a hypothetical household moving from renting to owning.  Using data from the Flow of Funds report and the BEA, for total owner-occupied real estate value and total imputed rent, the national average price to (annual) rent ratio was 15.6 in 2001 and 20.0 in 2006.  (This is more conservative than the rise implied by the Case-Shiller indexes.)  So, an average family in a home with $848/month rent could have purchased that home in 2001 for $158,690 - the average price for homes purchased with subprime loans that year.  But, by 2006, rent on that home would have risen to $979/month and it would have cost $234,902.  Even if they used a subprime mortgage, the average down payment for the average family went from $32,690 to $33,121.

Certainly averages hide some details about the distribution of mortgages.  But, it seems unlikely that broad based changes in down payments could have been a causal factor in creating unsustainably high home prices.

This also confirms another pattern I have been seeing, which is that rent inflation has been high.  That same hypothetical house was fetching more of the median family's income in 2006 than it had in 2001, even though real median household income had risen slightly.  Households were not purchasing larger homes (or, more accurately, homes which would fetch higher rents).  The average home purchased with a subprime loan in 2006 had rent that was a slightly larger portion of median family income, but over that time, subprime loans had grown from 7.6% to 23.5% of total mortgage originations.  Using Debt-to-Income, Mortgage Rates, and Average Loan Size from the Demyanyk and Van Hemert table, I estimate that the average income of subprime loan borrowers increased by about 35% from 2001 to 2006.  The average subprime loan borrower in 2006 was moving into a home with a lower rent/income value than the average subprime loan borrower had in 2001.

Demyanyk and Van Hemert also show that during the 2000s the premium borrowers had to pay via higher interest rates for having a low down payment was increasing as the boom progressed.

There certainly are some mysteries to be uncovered regarding the explosion of subprime lending in the 2000s, but the evidence suggests that, even among subprime borrowers, the trend from 2001 to 2006 was of higher income households making relatively larger down payments on homes with lower imputed rents relative to their incomes.  And that understates the downsizing they were engaging in, because rent inflation meant the same rent was getting less home.  Higher prices were not coming from lower income households making smaller down payments on larger homes.

29 comments:

  1. Do I love you or do I love you? I swear every time I read one of your posts there is something in there that supports my own pet theory of what happened. Keep it up!

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    1. Well, don't keep it a secret, baconbacon!

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    2. Short version- the subprime crisis was a symptom (and only a cause in a reinforcing way, not an initiator) of housing issues (not going to say bubble here) that started in the 90s. The hypothetical cause I had worked out was a distortion of the income/downpayment pattern.

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    3. Can you expand on the income/downpayment pattern? Don't be a cipher baconbacon. Spill the beans. We're listening....

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    4. Only have one free hand, 3 month old in the other.

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  2. Dang it- hit submit and it disappeared. OK the short short version.

    Uncle Sam says it will pay up to $50,000 to anyone buying a house- with the catch that the house can't sell for more than $50,000. There is a rush to buy all houses below 50k- and their prices all get pushed right up to 50k. Any person that bought a house the year before with 20% down for say 30k now can sell their house and walk away with 26k in cash- but they need a house. Previously their ability to save limited them to a 30k house (ignoring income for brevity) now they appear to be a "prime" borrower for a house worth up to 130k. Since many people with sub 50k houses now need somewhere to live there will be a bidding war on houses between 50k and X- pushing those values up, giving those sellers more purchasing power on their next home, ect ect ect.

    Punchline- if down payments aren't simply cushion for the bank, but carry information on credit worthiness (by demonstrating prudent spending/saving habits), then a broad windfall of cash unrelated to that credit worthiness can cause banks to make mistakes in how much to lend a person.

    baconbacon

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    1. That's a valid and subtle theory. But it seems to me that you're still begging the question. You're assuming that homeowners weren't credit worthy. You can get away with that just about anywhere but here. :-)
      Wouldn't your theory suppose that delinquencies would have come before the price collapse? And, wouldn't it suppose that delinquencies would have gone up more among low FICO score owners than among high FICO score owners?

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  3. I am not trying to assume they weren't credit worthy (though it does sound that way because I am using tons of shorthand)- but to discuss how the market's valuations of creditworthiness changed (or might have changed)- also its not binary- credit worthy or not isn't what I am interested in, but the sliding scale that banks work on. This guy, this house, this income, this down payment, this interest rate= no loan, but bump the IR up half a point and YES loan.

    Someone is waking up again so quickly- to your questions, (conditionally) no and no. Creditworthiness for a 30 year loan isn't about making payments on time when everything is fine- if you make loans that people can't pay back when things are going peachy you have made really big stinking mistakes. It is mostly about what happens to this loan when a health issue/divorce/recession hits? Will this person be able to meet obligations under most circumstances, not just optimal ones. Additionally rising home prices buffer the situation. A person struggling to pay but with equity can either sell the house/refinance/HELOC it and make ends meet or get out from the obligation (i haven't really worked through the implications here, but one *might* be that homes with Helocs would sell for less under foreclosure).

    #2- if banks use FICO scores/income/DPs as a three legged stool then lower FiCO scores would prevent some of the mistakes that are implied by higher DPs.

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    1. You have good points. My point regarding question begging is that these sorts of hypotheticals have been in the zeitgeist since before the crisis. They were causes in search of an effect, so they were accepted with a lot of anecdotal evidence and a lot of seeming empirical evidence. But, my work on this blog has been about checking the data and saying, you know what? there are some dots here that were never connected, and the empirical evidence is not as strong as we thought. In fact, it points to a very different story.

      So, for instance, you are correct about this possible effect of capital gains on household financial appearances. The paper I reference in the post mentions some of these issues. On the other hand, rising home prices related to falling long term real interest rates have effects pushing in the other direction, too. Partly what my post shows is that as nominal home values rose, a household who would be making a lateral move in housing consumption, but moving from renter to owner, would have similar costs, because the same factors that are causing the home price to rise would be partly mitigated by falling mortgage rates. But, in dollar terms, as the boom progressed, households actually needed larger down payments to buy the same house that would otherwise have the same debt payments/income ratio.

      And, in fact, the paper I reference is evidence that these mitigating factors were constraining. As the boom progressed, average incomes and credit scores of subprime borrowers were rising, and banks were increasing spreads regarding some of the risk factors on mortgages. They were reacting to the concerns you raise.

      So, my point is, there are lots of factors pointing in all directions, so it is possible to find hypothetical factors that defend the standard causation. But, you have to take the step of confirming that causation in the data. And, the point of all these posts I've been doing is that, against the data, that story fails.

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    2. I agree that the standard story has a ton of holes, and that you have done an excellent job of highlighting them. If it appears that I am defending that story specifically, it is only an artifact of the fact that you are attacking that position so my disagreements appear to defend it combined with the fact that I don't often comment when I agree with something. On the substance.

      I don't think it is fair to call it begging the question. First many loans went bad and secondly the structure of loans made during certain periods were at odds with (some) historical norms.

      "Partly what my post shows is that as nominal home values rose, a household who would be making a lateral move in housing consumption, but moving from renter to owner, would have similar costs, because the same factors that are causing the home price to rise would be partly mitigated by falling mortgage rates."

      One of my earlier responses to you (back in January iirc), was to point out the asymmetry between sellers, banks and borrowers. Higher nominal home prices with lower interest rates imply larger risks for lenders. Whatever you think the cause was some of these risks came to fruition and a much larger number (and nominal value) of loans went bad than the banking system was able to handle.

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    3. Baconbacon here again- i am not able to login to reply for some reason, and that is me one post up.

      There are almost always two ways to look at an issue in economics. You can take Prime lending defaults and say "they went way up as well, the problem wasn't the housing market, it was something else that has caused these problems" or you can say "Prime lending defaults went way up as well, the housing issues were much deeper than just subprime".

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    4. No worries. Your comments are a welcome addition to the conversation.

      I agree with you that there were unusual risks associated with the housing market, and there were clearly losses. I even agree that the losses were larger because of the peculiar nature of the risks at the time. The recession was worse than it would have been because home prices had farther to fall, as it were. But I'm going to be a stickler about the causation.

      If the Fed had been accommodative in 2006, and rising real interest rates caused a 5% dip in home prices that led to a larger than normal rise in delinquencies among houses with financially marginal owners and an unnecessarily deep recession, you'd have a case for causation. But that didn't happen.

      The reason I push back against this is that it is very clear that mortgage markets are way too constricted right now, and home prices are way too low, relative to bonds. This is a broken market. I don't care what level home prices are. I just want them to be efficient. A fair, functional economy depends on that. And, the idea that the lesson we need to learn from all of this is to limit access to mortgage credit and keep home prices from getting too high is exactly the wrong lesson. It's the lesson almost everyone has taken from it, and we seem destined to damage ourselves further because of that.

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  4. Last paragraph first- The mortgage market does look broken to me as well- but the bond market looks really broken. Banks have plenty of loanable funds, and have done for years now. If the Fed's 0.25% rate (correct me if I am wrong, but isn't that a cap, not the acutal rate, and the actual rate has averaged somewhere in the 0.18% range- that tidbit is in my memory, but I don't know that it is reliable) is keeping banks from lending that would imply some pretty massive problems in the market. This is well under the spread banks usually earn afeter adjusting for defaults.

    I don't think your middle paragraph holds unless

    1. You think the Fed was never going to tighten and
    2. No other economic event would have caused a shock that would have percipitated the crisis.
    3.

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    1. You're begging the question again. You're assuming that the crisis was inevitable.

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    2. The Fed has tightened before without causing a severe financial crisis- if my position is begging one question, then yours is begging another.

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    3. The Fed tightened much more this time than they have during other recessions. For goodness sake, in September 2008, two years into the crisis, with home prices down over 25%, Emergency Unemployment Insurance already enacted, the day after Lehman Brothers failed, with currency growth at 2.5% - a growth level that it had been on for two years - at a meeting where their head trader told them that half the market expected the bottom to fall out of the economy, they made a tactical, discretionary decision to leave the target interest rate at 2%, when the market was expecting a decrease, as a firm stand against inflation. Most of the real estate delinquencies happened after that meeting, and almost all of the unemployment did.

      You're welcome to any opinion you want, but if you think I'm begging the question, you haven't been reading the blog.

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    4. This was not my opinion about these things before I started to look at the data.

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    5. I don't mean to be too ornery. Your position isn't crazy. You saw a really seedy looking character running into a house with a gun. You ran in after him. When you got there, he was standing in one corner, gun drawn, and a bloody body was in the other corner. It seemed like an open and shut case.

      But, I've decided to come in as a visiting coroner and look at the body, and I was shocked to find out that it was a knife wound, not a bullet wound. And, after investigating further, I realized that we don't have any witnesses that heard a gun shot.

      Your position is perfectly understandable and I am making demands that must seem unreasonable.

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    6. Finding a knife wound doesn't exonerate the gunman. "Ill go in the front with a gun, if he stands his ground I shoot him, if he runs out the back you are waiting there with a knife" You and I agree on the knife wound/gun wound disparity, but you think the fed weilded the knife, while I think the Fed is the guy that got stabbed.

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    7. You just blew my mind, baconbacon. Well played. :-)

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    8. I am really enjoying myself here, and love how you respond not only to your replies, but respond the the substance (which is surprisingly/dissapointingly rare). Every 20 mins of peace Ihave had the past two weeks has been spent reading your blog/responding.... for a total of maybe 2 hrs :).

      Dishes are calling.

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  5. If I am begging the question- then you answered it above. Thge two largest bankrupcies (Counting AIG) in US history were baked into the pie in August 2008. The business models of two major financial institutions were exposed as broken, and the business models of anyone relying on counterparties (that weren't able to print their own currency) were also exposed as deeply, and argualbly fatally, flawed. It would have been bizarre for banks to return to these practices immediately after their failures,

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    1. Exactly right. If we are going to insist on giving monopoly power over currency to a committee that is capable of being horrendously wrong (and who isn't?), then the only sustainable business model is to be that monopoly currency producer. As long as that is our policy, business models that aren't able to print their own currency are fatally flawed. The only saving grace is that the Fed has a conscious mandate of stability, so that they eventually dress the wounds, even if they won't admit that they were the perpetrator.

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    2. There is the possibility that dressing wounds is what set up the crisis, and the better you dress the wounds the worse the next crisis is. This is why I worry for China.

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    3. This is where I think there is a deep flaw in thinking about the business cycle and financial assets. Low real interest rates are related to high risk premiums and, if anything, lower corporate leverage. Low interest rates are a symptom of risk aversion, not risk-taking. Low interest rates mean that savers are willing to take a larger discount to avoid variance in cash flows. High debt levels and equity levels in real estate are a product of this risk aversion.

      The idea that what savers in a low real interest rate environment need is a dose of unmanageable instability is awful, awful, awful. It really is the modern equivalent of bloodletting - of experts creating unnecessary destruction because they are imposing their incredibly wrong paradigm on their subjects.

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    4. How does one (the fed) encourage risk taking then? Two ways leap to mind- one is a reminder that low risk doesn't equal risk free, the other is to generate excess returns for risky assets. Both contain issues for the Fed.

      I disagree with your bloodletting analogy though. There were real problems as highlighted by Lehman and AIG- bloodletting is the intervention of a 3rd party, a market correction is the "normal" process.

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    5. Lehman and AIG were a result of the bloodletting. But, even then, the day after Lehman collapsed, the Fed announced that they were going to drain one more pint. And, literally by the end of that day AIG had collapsed. The Fed still insisted on implementing interest on reserves after that and even then only slowly reduced rates to near zero and it was 3 more months before they initiated QE. But all of that was after 2 years of draining. Just typing it out in one place, it seems like it couldn't have happened that way, let alone that years later the Fed would be seen as the hero or as Wall Street's benefactor.

      Why would they want to encourage risk taking? Why is that such a normal intuition? There is a groundswell of emerging and developing markets which are very risky, investment in developed markets is highly exposed to a tech revolution, baby boomers around the globe are preparing to outlive the part of their lives where they are productive, and incomes are going to human capital instead of physical capital in an unprecedented way. Those are all legitimate, wonderful reasons why markets may be looking to counterbalance excess risk. They don't need our correctives. Now, we have created more demand for safe assets by engineering a useless, pointless crisis that created risk which serves no purpose. In the meantime $20 trillion in previously low risk real estate assets has vanished. And you're going to celebrate this because it teaches those risk averse investors a lesson?

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  6. Appropos of nothing- http://www.smbc-comics.com/index.php?id=3721

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